I don't know about you but I love amusement parks. Rollercoasters are my favorite. I can't get over the thrill of being tugged up a monstrous hill by a rusty chain only to be dropped mercilessly hundreds of feet toward the encroaching earth.
If you look at the historical chart of Bitcoin prices, you'd be excused if you mistook it as the plans for some new rollercoaster at Six Flags. Those of us who have been following Bitcoin for some time have grown very accustomed to the fast and vast swings in price. In any normal day, it's common to see the price move 10% to 20% and when it swings big, it swings big.
So why do we endure these large swings and put our financial faith in something so blatantly inconsistent?
Because no matter the swings, when you look at the fundamentals, Bitcoin is woefully undervalued.
Now before you go and dump your life savings into Bitcoin at the word of an amateur armchair economist, there are plenty of much more educated individuals who disagree with me (Paul Krugman, Nicholas Jackson ). But let me lay out the case for the real value of Bitcoin.
Bitcoin Defined
At the risk of simplifying things too much, I'll just say that Bitcoin is basically four things.
- An international currency like the Euro or Yen.
- A precious commodity like gold.
- An account of stored value like your savings account.
- An online network for transfer of value between people, like SWIFT, ACH or simple wire transfers at the bank.
If you need a more detailed description of Bitcoin, check out the pages at CoinDesk and WeUseCoins.
Supply and Demand
Everyone basically understands the rule of supply and demand. When supply outpaces demand, the price goes down and when demand outpaces supply, the price goes up.
The supply of Bitcoin was modeled closely after gold in that it must be mined and cannot be counterfeited or printed. When all of Bitcoin has been mined, that's it. There will be no new Bitcoin. This well defined restriction makes supply a constant in the Supply and Demand equation. If supply is constant and expected, then really you can consider Bitcoin a purely demand based currency.
This has proven itself throughout the history of Bitcoin with each major boom following significant media coverage resulting in more demand with busts often corresponding to negative events in the currency (it's important to note that each Bitcoin bust has landed solidly above it's prior lows).
Knowing this then, we just have to ask ourselves what the long term demand will be for Bitcoin and we'll be able to calculate what long term price to expect.
Market Potential
To understand the value of Bitcoin, you need to investigate what it will be used for and the market potential of those activities.
The obvious use for Bitcoin is as the go-to currency of the Black Markets. By this I don't just mean Silk Road (which was recently shut down), but any underground markets where anonymity is important. Things like international arms exchange, human trafficking and hobo kidneys, while not exactly respectable business, are primed for a good digital anonymous currency. Why every single prostitute in Las Vegas isn't already accepting Bitcoin today, I'll never know (and I mean I'll never know). They will eventually.
Black markets around the world account for 22% of the world's economy for a $650 billion currency value. With less than 12 million Bitcoin in existence, if Bitcoin were used in only 5% of worldwide black market activity, it would be $2700 per Bitcoin.
Or how about the offshore banking industry? The USA has been bearing down on offshore banks holding accounts for Americans. As such it has become harder for individuals to legitimately store money in banks worldwide. Wealthier individuals will buy Gold as a store of value, but getting that across borders is hardly safe and usually not so legal.
Bitcoin is a terrific store of value and can be your onshore-offshore bank account. Moving Bitcoin across borders is as easy as sending an email, uploading a file or sending a postcard via snail mail. And it's easily convertible into nearly any currency you might need when you need it.
It's estimated that $30 trillion is stored in offshore accounts worldwide. If just 5% of that was stored in Bitcoin, expect each one to be priced at $128,000.
And finally, every time you buy something online with your credit card, the merchant is hit with a fee (sometimes as high as 8%) for the right to take your money. Bitcoin transactions are extremely low cost and prime for taking over in the world of online purchases. In 2012, over $1 trillion was spent in e-commerce transactions. Should Bitcoin take only 5% of the online payment market, one coin would be over $4k.
<< UPDATE >>
An astute reader on Reddit pointed out that my logic in the last paragraph was a bit flawed. That $1 trillion was spent does not take into account that the same dollar may have been spent multiple times indicating a much smaller monetary base. Assuming the same dollar was spent 10 times, we will use the number $100 Billion as the monetary base of e-commerce transactions. If this value is accurate and we still assume that Bitcoin can take 5% of the market, that places the value of a bitcoin at $420.
Target Price
So when I look at the outlook for Bitcoin in the long term, I do think Bitcoin is vastly undervalued at today's $180 price. My optimistic outlook has Bitcoin over $1000 within the next two years (and over $10k in the next 10 years). My pessimistic outlook still has Bitcoin reaching $1000 in the next 6 years.
Of course there is always the risk that something could happen to send Bitcoin to nothing. Given the resilience it has shown to this point, I personally don't see that happening, but anything is possible.
My recommendation is that if you are the type of person who will drive yourself crazy over short term losses, then maybe you should avoid rollercoaster investing entirely and skip the Bitcoin. But if you want to be a part of something very exciting, knowing that the long term rewards will far outweigh any short term losses, I highly recommend to buy and hold some Bitcoin as soon as possible.
Oh and for a really fun little tool to calculate the price of bitcoin over time, check out this Techcrunch article:
http://techcrunch.com/2013/06/02/calculating-the-long-term-value-of-a-bitcoin/